The very first step in obtaining a mortgage is to find out how much money you can borrow. It’s important that you know how much you can afford even before you begin looking for a house to help you stay on track and not get in over your head.
Are You Ready Financially?
Before going to any lender, take the initiative of evaluating your own financial situation first. You would be in the best position to determine how much debt you can take on. Take into account the following factors when evaluating your situation:
- Total household income
- Monthly expenses (car payments, bills, credit card payments)
- Estimated monthly housing costs (mortgage payments, property taxes, property insurance, condominium fees, school taxes, utilities and maintenance costs)
- Closing costs and other upfront costs (Legal/ notary fees, mortgage default insurance premium, appraisal fee, home inspection fee, title insurance) – Estimate closing costs to be about 1.5% to 4% of the price of your house.
- Your down payment – If you pay down payment that is less than 20% you’ll be required to purchase mortgage default insurance which is added costs.
- Cash reserves that can be put towards the house
Don’t forget to also factor in ‘planned expenses,’ which are any costs or payments that you know are on the horizon. For instance, you may be planning to have a baby soon so you will have to consider expenses related to having a baby as well as any adjustment that a maternity or paternity leave will have on your income.
After calculating the amount you are able to pay, think things through:
- Are you comfortable with the amount you will be paying for years to come?
- Can you afford to make payments and still be able to live the lifestyle that you want?
- Can you afford payments and still be able to save up on other major concerns, such as college education, retirement, etc.
- Will everyone be willing to change current spending habits, if necessary, to prioritize loan payments?
The process will help to mentally prepare you and your family for the huge financial responsibility ahead.
How Lenders Determine Your Affordability
Lending institutions have varying guidelines for approving loans that depend on the terms of each loan, although they follow standards set by Canadian government agencies. In general, loans are approved based on your ability to repay the loan and the value of the property. To look at this mathematically, lenders calculate your “debt service ratio.”
Lenders use two different debt service ratio calculations:
- Gross Debt Service Ratio or GDSR – This is calculated based on your estimated housing costs (mortgage payments, taxes, heating costs, and condominium fees, if applicable) and gross monthly income. As a general rule, your GDS amount should not be more than 32% of your gross monthly income.
- Total Debt Service Ratio or TDSR – This includes all your estimated housing costs plus all your current debt payments (car loans or leases, credit card payments, lines of credit payments, etc.). This number indicates your entire monthly debt load and should not be more than 40% of your gross monthly income.
Calculating your Mortgage
Mortgages are not simple to calculate at all. It involves a lot of compounding that’s worked out semi-annually according to the law, with the exception of variable rate mortgages. Working out the formulas can really leave you feeling nauseated. However, you can do this quite easily using a Mortgage Calculator which allows you to compare mortgages using different interest rates, principal amounts, amortization terms, etc.
Your mortgage specialist should be able to guide you through the entire mortgage process. He can help you understand terms and related costs, as well as calculate exactly how much you can afford to borrow, and recommend the best type that is right for your budget to keep your payments low and manageable.